Comparing the FX Market with Equities

By: Kathy Lien

The following is an excerpt taken from Kathy Lien’s Day Trading the Currency Market

Traditionally FX has not been the most popular market to trade because access to the foreign exchange market was primarily restricted to hedge funds, Commodity Trading Advisors who manage large amounts of capital, major corporations, and institutional investors due to regulation, capital requirements and technology.  One of the primary reasons why the foreign exchange market has traditionally been the market of choice for these large players is because the risk that a trader takes is fully customizable.  That is, one trader could use a hundred times leverage while another may choose to not be leveraged at all.  However, many firms have opened up the foreign exchange market to retail traders, providing leveraged trading as well as free instantaneous execution platforms, charts, and real-time news.  As a result, foreign exchange trading has surged in popularity, increasing its attractiveness as an alternative asset class to trade.

Many equity and futures traders have begun to add currencies into the mix of products that they trade or have even switched to trading currencies exclusively.  The reason why this trend is emerging is because these traders are beginning to realize that there are many attractive attributes to trading FX over equities or futures.

FX versus Equities

Here are some of the key attributes of trading spot foreign exchange compared to the equities market.

FX Market Attributes

  • Foreign exchange is the largest market in the world and has growing liquidity.
  • There is 24-hour around-the-clock trading.
  • Traders can profit in both bull and bear markets.
  • Short selling is permitted without an uptick, and there are no trading curbs.
  • Instant executable trading platform minimizes slippage and errors.
  • Even though high leverage increase risk, many traders see trading the FX market as getting more bang for the buck.

Equities Market Attributes

  • There is decent market liquidity, but it depends mainly on the stock's daily volume.
  • The market is available for trading only from 9:30 a.m. to 4:00 p.m. New York time with limited after-hours trading.
  • The existence of exchange fees results in higher costs and commissions.
  • There is an uptick rule to short stocks, which many day traders find frustrating.
  • The number of steps involved in completing a trade increases slippage and error.

The volume and liquidity present in the FX market, one of the most liquid markets in the world, have allowed traders to access a 24-hour market with low transaction costs, high leverage, the ability to profit in both bull and bear markets, minimized error rates, limited slippage, and no trading curbs or uptick rules.  Traders can implement in the FX market the same strategies that they use in analyzing the equity markets.  For fundamental traders, countries can be analyzed like stocks.  For technical traders, the FX market is perfect for technical analysis, since it is already the most commonly used analysis tool by professional traders.  It is therefore important to take a closer look at the individual attributes of the FX market to really understand why this is such an attractive market to trade.

Around-the-Clock 24-Hour Market

One of the primary reasons why the FX market is popular is because for active traders it is the ideal market to trade.  Its 24-hour nature offers traders instant access to the markets at all hours of the day for immediate response to global developments.  This characteristic also gives traders the added flexibility of determining their trading day.  Active day traders no longer have to wait for the equities market to open at 9:30 a.m. New York time to begin trading.  If there is a significant announcement or development either domestically or overseas between 4:00 p.m. New York time and 9:30 a.m. New York time, most day traders will have to wait for the exchanges to open at 9:30 a.m. to place trades.  By that time, in all likelihood, unless you have access to electronic communication networks (ECNs) such as Instinet for pre-market trading, the market would have gapped up or gapped down against you.  All of the professionals would have already priced in the event before the average trader can even access the market.

Lower Transaction Costs

The existence of much lower transaction costs also makes the FX market particularly attractive.  In the equities market, traders must pay a spread (i.e., the difference between the buy and sell price) and/or a commission.  With online equity brokers, commissions can run upwards of $20 per trade.  With positions of $100,000, average round-trip commissions could be as high as $120.  The over-the-counter structure of the FX market eliminates exchange and clearing fees, which in turn lowers transaction costs.  Costs are further reduced by the efficiencies created by a purely electronic marketplace that allows clients to deal directly with the market maker, eliminating both ticket costs and middlemen.  Because the currency market offers around-the-clock liquidity, traders receive tight competitive spreads both intraday and at night.  Equities traders are more vulnerable to liquidity risk and typically receive wider dealing spreads, especially during after-hours trading.

Low transaction costs make online FX trading the best market to trade for short-term traders.  For an active equity trader who typically places 30 trades a day, at a $20 commission per trade you would have to pay up to $600 in daily transaction costs.  This is a significant amount of money that would definitely take a large cut out of profits or deepen losses.  The reason why costs are so high is because there are several people involved in an equity transaction.  More specifically, for each trade there is a broker, the exchange, and the specialist.  All of these parties need to be paid, and their payment comes in the form of commission and clearing fees.  In the FX market, because it is decentralized with no exchange or clearinghouse (everything is taken care of by the market maker), these fees are not applicable.